Talking Yahoo ahead of its Q3 report

BambiFrancisco

SAN FRANCISCO (CBS.MW) -- Somewhere along the way, a few zeros were lopped off.

SoundView Technology Group is advising clients to sell Yahoo
YHOO
at $12 and buy at $6. Recall, it was at the start of 2000 that Yahoo shares had a price target of $600 from another analyst.

SoundView's Jordan Rohan recommends that investors sell into rallies, citing a decline in future expectations. He said the company might report a "respectable" third quarter but that consensus expectations for revenue and earnings will continue to fall.

Yahoo will kick off the third-quarter reporting season for Internet companies when it reports after the close Wednesday.

Hitting projections

Unlike many companies that issued warnings for the quarter, Yahoo did not.

Several analysts, however, did lower their estimates following Sept. 11, bringing the consensus third-quarter revenue forecast down slightly to $170.5 million from $170.8 million. The consensus pro forma earnings of 1 cent stayed the same.

More importantly, investors will focus on whether Yahoo is successfully diversifying its revenue stream. Currently, Yahoo generates 82 percent of sales from advertising.

Additionally, analysts are focused on how much Yahoo will have to lower revenue and earnings forecasts for the fourth quarter and next year.

Bracing for some disappointing news, analysts have begun chipping away at this year's forecasts.

After Sept. 11, the consensus 2001 earnings projection slipped by 2 cents to 11 cents per share. Analysts surveyed by Thomson Financial/First Call expect Yahoo to generate $721.85 million this year. It's unclear whether these numbers assume that Yahoo leads analysts to lower their fourth-quarter projections. At the moment, Yahoo is expected to earn 1 cent a share on revenue of $192.16 million in the fourth quarter.

What seems clear is that Yahoo's current 2002 projections are extremely optimistic. In 2002, analysts expect Yahoo to grow annual earnings to 11 cents a share, up from 5 cents. Annual sales are expected to grow by 18 percent to $854.32 million.

Yet overall advertising in the U.S., as measured by Morgan Stanley, is expected to grow by 0.2 percent in 2002. The investment bank lowered its outlook after Sept. 11. Prior to Sept. 11, it expected overall advertising in the U.S. to grow by 3.4 percent.

Salomon Smith Barney analyst Lanny Baker expects online advertising to grow by 10 percent next year, after being flat this year. He also estimates that Yahoo's revenue will grow by 10 percent.

Perceived value

Yahoo shares have been under pressure as investors value the company at lowered expectations.

Still, at current levels, Yahoo does have a market valuation of some $6 billion. Yahoo also has a significant amount of cash and cash equivalents.

On a per share basis, Yahoo traded at $10.16, down 3 percent in recent trading. At current levels, it trades at 93 times its expected earnings of 11 cents per share in 2002.

But does valuation based on earnings make sense?

Investors are paying a "brand premium and takeout premium for Yahoo," said Derek Brown, an analyst at W.R. Hambrecht.

"Yahoo's value has a lot less to do with next year's earnings," said Rohan. "This stock is trading between its going concern value and a level equal to a potential takeout value."

Yahoo can be worth a few hundred million in cash flow to the right strategic buyer, he said. But its valuation is still a barrier to a deal getting done, he added.

Moreover, it's a difficult environment to assess how much value Yahoo can add to a larger company if it's difficult to assess what Yahoo could earn by itself, Rohan said.

Whether Yahoo can generate 11 cents next year depends a lot on the overall advertising environment. That dependence has been its nemesis.

Web conferencing

"In a sea of red ink, WebEx will exceed Wall Street expectations on both top- and bottom-line, again," said John Corcoran, an analyst at CIBC World Markets, who doesn't see WebEx's $1 billion market valuation as unreasonable. "This company has grown its revenue and improved its bottom line consistently," said Corcoran. "It has a sound business strategy and proven business model. It's not relying on advertising."

CIBC World Markets was one of the co-managers of the WebEx initial public offering.

Overall Net

Investors are keeping in mind that uncertainty will need to be factored in for a longer period, if President Bush's words to America at 11 a.m. EST are any hint as to what to expect.

"This will be a long war and requires patience and understanding," said Bush.

To this end, prolonged uncertainty compresses multiples and just adds to a growing number of negatives, not the least of which is the recent run-up driven by fiscal and monetary stimulus -- but that has little to do with improving fundamentals, such as increased demand by consumers and corporations.

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